Putting the squeeze on the banks

 

ANALYSIS:There is serious concern at the power invested in the Minister for Finance by the new banking Bill

ON TUESDAY the Government published what has been described as one of the most important pieces of financial regulation in the history of the State.

The Credit Institutions (Stabilisation) Bill 2010, which was passed by the Dáil on Wednesday, will give the Minister for Finance sweeping powers to restructure the banking sector, including the power to overrule shareholders, sack directors, impose losses on bondholders and transfer loans and deposits out of Irish banks.

The content of the Bill has been met with criticism from both economists and the Opposition – the Labour Party said the legislation seeks to turn the Minister into a one-man legislature – but how draconian is the Bill, and how does it compare to similar banking legislation in other countries?

One of the reasons the Bill has attracted such a level of attention and scrutiny is that it is the first stage in the establishment of what is known as a “special resolution regime” in Ireland.

Special resolution regimes, or SRRs as they are commonly known, are a system of laws that provide central banks and governments with the tools to deal with failing banks in a prompt and more orderly fashion.

In many countries – including Ireland – troubled banks have traditionally been dealt with through regular corporate insolvency procedures, and as such are subject to the same sort of insolvency options that apply to ordinary companies, such as examinership, administration, etc.

In effect, national authorities have been left with two options in dealing with insolvent banks – applying for regular corporate bankruptcy proceedings or injecting public money into the banks, thus nationalising the banks.

However, the current financial crisis has starkly highlighted the shortcomings of the system, as bank after bank has failed, bringing countries to the brink in the process. There has been a growing conviction that the unique status of banks – in particular their function as deposit repositories and lenders and their wider systemic role in the economy and society – means that a specific banking resolution framework needs to be developed, something that has been proposed in academic circles for years.

While Europe has been behind the curve in terms of adopting SRRs, special resolution regimes have long been in place in the US, Canada and Japan. The US adopted banking resolution legislation as far back as the Great Depression, with the legislation renewed during the savings and loan crisis of the early 1990s.

More recently, stringent measures were adopted in the Dodd-Frank Act, which was enacted earlier this year in response to the US financial crisis. Despite the widespread implementation of the American SRR system – the Federal Deposit Insurance Corporation (FDIC) acts as a receiver to banks, regularly closing down banks within a few days – one shortcoming of the system is that it does not apply to non-deposit financial institutions, which explains why Lehmann Brothers and Bear Stearns could not be dealt with in this way.

Europe has come belatedly to SRRs. While there is currently no harmonisation at EU level of the national laws governing bank resolution, some countries have more sophisticated systems than others in terms of the range of authority granted to various national authorities and bank-specific modifications to their general law.

The last few years have also seen a number of countries rush to introduce special banking measures in response to the crisis. Most notably the UK introduced a special resolution regime in February 2009 in the wake of the collapse of Northern Rock. The SRR act allows the UK authorities – the Bank of England, the Financial Services Authority and the treasury – to implement a range of powers, including the transfer of all or part of a bank to a private sector purchaser or to a bridge bank, which would be a subsidiary of the Bank of England pending a future sale, winding up a bank through a bank insolvency procedure (bip) or putting parts of a bank into administration.

Germany and Denmark have also introduced new special banking resolution legislation in the past few months.

It is within this context that Ireland’s Credit Institution (Stabilisation) Bill 2010 passed this week is operating.

The Bill itself is a form of emergency legislation. The main special resolution regime legislation is set to be introduced to the Dáil by the end of February. Its implementation by March is a condition of the IMF-EU rescue package pledged to Ireland. The Central Bank has a dedicated team working on special projects and a special resolution regime which it instigated earlier this year.

The argument for an Irish SRR has been gaining ground in recent years as Ireland’s financial crisis has unfolded. Economists such as John McHale and Colm McCarthy have long argued for the need for such measures, while last year’s IMF report on Ireland said that the Government was “open to exploring the merits of a special bank resolution regime”.

Financial Regulator Matthew Elderfield also spoke of the advantages of such a system at an Oireachtas Committee in October, saying that it “would provide the Central Bank with a full tool kit for the future and is best practice internationally”.

This week’s Bill, which is applicable until 2012, is the first indication of what an Irish special resolution regime will look like.

The response so far to this week’s document has been characterised by a mixture of frustration that such legislation was not introduced earlier, and serious concern about the level of power being invested in the Minister for Finance.

The Department of Finance has stressed that this is temporary legislation that will be superseded by February’s Bill. While it says that the Credit Institutions (Stabilisation) Bill does constitute a “targeted” special resolution regime designed to facilitate specific restructuring and reorganisation measures that are expected to take place over the coming months, a “full-SRR regime” will be introduced to the Dáil by the end of February.

In this sense, the negative reaction this week to the Bill mirrors a similar reaction in the UK when a temporary resolution regime was introduced immediately following the Northern Rock crisis. The UK then went on to engage in significant consultation with stakeholders – including the City, and representatives of the law and accountancy profession – before publishing their final Bill, which came into effect in February 2009.

So far, indications of the specific measures that will be in Ireland’s “full SRR” are unclear.

The Department of Finance has said that the full range of SRR powers will be introduced “based on international best practice”, while the memorandum of understanding says it needs to be “consistent with similar initiatives going on at EU level.”

Within the EU itself, there are a variety of bank resolution regimes in place.

In Spain, for example, the Bank of Spain has a broad range of powers, but for systemically important banks the Bank Restructuring Fund has sole authority to initiate liquidation proceedings.

Among the distinguishing features of the UK’s SRR is the ability to trigger the mechanism before a bank is “balance sheet insolvent”. It also has a more explicit and comprehensive set of safeguards to protect shareholders, creditors and counterparties of a failing bank, including bondholders.

Mark Kennedy, a partner at accountancy firm Mazars, which is soon to publish a research document on SRRs, believes that serious consultation needs to take place over the coming months as the details of Ireland’s SRR is worked out.

He believes that Ireland could draw on the Danish model. Denmark has just revised its temporary special resolution scheme introduced in October 2008. “Firstly the Danes put the regime in place earlier in the crisis. Secondly it deals with the issue of moral hazard in that it places the responsibility for bank breakdown on the banking federation first and foremost. The SRR operates under a joint agreement between the Danish government and the Danish Bankers’ Association. If a bank fails, the bank is transferred to a state-owned winding up company, and the cost is borne by the other banks. A levy is in place to fund that.”

The exact shape Ireland’s SRR will take is still unclear, and Ireland is unique in that the legislation will have to interact with the guarantee. But some of the key issues that are likely to be debated over the coming months are: what threshold will need to be reached to initiate the proceedings, the exact nature of the powers granted to the official administrator, the respective roles of the banking authorities and the courts, and the extent to which creditors, including depositors, will be protected.

The next few months should see some robust debate and discord about what kind of long-term SRR Ireland, however belatedly, should have in place. What will unite all parties, however, is the regret that such legislation was not in place before the disastrous demise of Ireland’s banking system.